Consider the following two-player sequential move game. Player 2 is the incumbent firm in a market while Player 1 is considering entering this market. If Player 1 does not enter then the game ends. Player 1 earns $0 and Player 2 earns $80 million. If Player 1 chooses to enter, then Player 2 has two choices: To Accommodate Entry or to Fight Entry. If Player 2 chooses to accommodate entry, then Player 1 earns $10 million while Player #2 earns $50 million. If Player 2 chooses to fight entry, then Player 1 loses $1 million while Player 2 loses $2 million. The subgame perfect equilibrium of this game is:
A) Player 1 to not enter this market.
B) Player 1 to enter and Player 2 to accommodate entry. .
C) Player 1 to enter and Player 2 to fight entry.
D) Player 1 to not enter and Player 2 to fight entry.

Question

Quizplus · Accepted Answer

In a subgame perfect equilibrium, players make rational decisions at every stage of the game, taking into account the future actions of other players. In this game, if Player 1 enters, Player 2's best response is to accommodate entry because it leads to a higher payoff ($50 million) compared to fighting entry (-$2 million). Anticipating this, Player 1's best decision is to enter the market, expecting to earn $10 million. Therefore, the subgame perfect equilibrium is for Player 1 to enter and Player 2 to accommodate entry.

Consider the Following Two-Player Sequential Move Game